Gold: Big picture unchanged

Aside from thus far unrealized expectations for inflation (at least in official figures) arising from record money-printing around the world, the strongest argument in gold’s favor is the return of central banks to the demand side of the gold market.

For decades, central banks were supplying gold to the market as they diversified away from noninterest bearing bullion into the government bonds of reserve currency countries. Last year, however, central banks added approximately 530 metric tonnes to their reserves, the most since 1964 – and this does not include China, which is believed to be a heavy buyer of the metal. Turkey, South Korea and Brazil all nearly doubled their gold holdings in 2012, and Russia also significantly increased its holdings. Combined, these four central banks purchased 368 metric tonnes through February year-over-year, constituting the bulk of disclosed central bank purchases. At the same time, there were no notable sellers among central banks.

The buying bonanza seems set to continue in the years to come. In Switzerland the Swiss People’s Party, the largest in the Federal Assembly, has collected the 100,000 votes necessary to call a national referendum requiring the Swiss National Bank to hold at least 20% of its reserves in gold. If passed, the proposal would require the SNB to almost double its current holdings by buying more than 1,000 tonnes of the yellow metal.

Long positions are not without risk. The selloff was preceded by news that Cyprus would sell €400 million worth of gold to help finance its bailout. While Cyprus has a relatively small amount of gold, other troubled European states do have significant holdings. Combined, Portugal, Spain, Italy and Greece own 3,228 tonnes.

We remain long-term bulls on gold, and see value at current levels. Volatility is prone to arise, so stops should be placed carefully.